Credit cards are only detrimental when they’re not used properly

By BOB CUNNINGHAM

In a perfect world, everyone would carry about four or five credit cards yet no one would have a balance at the end of the month.

And now back to reality…

Okay, I suppose I should lend some clarification to that opening paragraph:  The truth is that credit cards can be our friends, and actually enhance our wealth (primarily on a smaller level) IF they’re not misused and/or abused.

There are varying attitudes about plastic money – ranging from considering them indispensable to labeling them as downright evil. Mostly, though, they are simply misunderstood… and most definitely improperly utilized. Bottom line, if you use credit cards with some intelligence – and a big heaping helping of common sense – you will benefit.

The vast majority of people, especially young adults as well as teens unlucky enough to have access, use credit cards to purchase “stuff” they can’t afford otherwise.  A new stereo system, the most up-to-date cellphone, that dope blouse she just has to have… these are items that fall under the immediate gratification category, and should only be bought with saved cash that has been set aside for that specific purpose.

We’ve all been in this situation, or at the very least known someone who has.  A giant credit card balance is run up, but when the bill arrives and only asks for a minimum payment of $25, we reason that we can afford that… so what’s the problem?

I just wrote about how credit cards work, their interest rates, and how paying off an account one minimum payment at a time is a long road to ‘Brokesville’ in a recent post.  Instead, what we want to touch on this time around is how Visa, Mastercard, Discover, and the rest can be used in our favor.

All those offers we receive from credit card issuers via spam or junk mail are due to what has become an extremely competitive industry.  Credit card companies realize you have a lot of choices, and they want to come off as having the best available perks.  This attempted “one-upsmanship” by these companies works in your favor, and you should be prepared to pounce – the correct way.

In fact, credit card companies will work so hard for your business, most are willing to pay you to use them. Seriously. They offer incentive in the form of rebates – cash credited back to you depending on what you buy, where you buy it, and how much you spend.  Used wisely, this is a boon for you.

For the sake of discussion, we are going to focus in this space on cash-back offers as opposed to frequent-flyer miles or any other type of credit card rewards. The principles I’m about to reveal are similar with all of the above.

Essentially, there are two types of cash-back cards.  Some, like Capital One, offer a flat percentage of cash-back on every purchase you make using its card.  I believe that rate is currently 1.5% back (at least, that’s what Jennifer Garner and Samuel L. Jackson have been telling us).  And those endorsers push the “we pay on everything” aspect very hard.  No messing with odd offers on specific items, they will tell you.  Just use their card anywhere and get a reward every time.

Others, like Discover and Chase, have promotional offers that usually go by quarters during the year – three-month time-frames.  This may sound somewhat limiting, but the fact is they represent a much better overall deal for you.  For instance, a card might offer as much as 5% cash back on gasoline purchases from January through March, then switch to groceries for April-June.  In addition, they typically offer a flat 1% on everything else.

Pretty sweet, I say.   If I spend $80 at the supermarket, that’s $4 refunded to me by my card. That’s enough to cover my box of protein bars. Works for me.

If you’ve read this far, you probably have a question similar to the following:  OK, the cash-back is nice and all, but it defeats the purpose to run up a big balance that charges 20% interest or maybe more. You can’t use a credit card to buy necessities!  That’s a sure-fire way to bankruptcy, isn’t it?

Am I warm?  Well, the answer is that running up a balance would be utterly stupid and would, indeed, nullify the advantage of these comparatively small cash-back offers.  But who said anything about running up a balance?

Bear in mind that these purchase examples are things you would buy anyway.  Most folks need gas for a car, or a motorcycle, or whatever… and EVERYONE needs to eat. The trick is simply to use the appropriate card when the items are bought, then have the basic discipline to pay the account in full during the grace period rather than allow the charges to accumulate.

Shazam!  Free money.

Of course, I’m guilty of glossing over the part about paying the balance in full each month.  For many, many people, there is NOTHING SIMPLE about paying off several hundred dollars in one click, swipe, or written check.  But for this to work for you, it MUST be done without compromise.  Every single month.

Think you can take advantage of this simple strategy without going into debt that lasts longer than a couple of weeks?  Great!  If you can, here are the steps to make things easier to get going:

1. Do some research into different card offers to see which offer what rewards in specific categories.  Ideally, you’d like to get access to as many 5% offers as possible for different types of purchases. (Note:  At this writing, American Express is offering a card with a short-term 6% cash-back on groceries, but the card carries an annual fee and some other disadvantages.  Be sure you know exactly what is required and included before you apply).

2. Try to end up with three cards – one you can use for groceries, one for gas, and a third for eating out – restaurants are a common category for cash-back promos but, of course, don’t over-use this to the point of spending more to eat than makes sense.  Be smart.  You may not find 5% cash-back cards for all three categories, and if you don’t, 3% is still decent.  Also, a fourth card for miscellaneous purchases with a steady cash-back percentage is nice to have available.  But again, discipline in its use is everything.  Only buy necessities you would have bought anyway.

3. Budget yourself so that you are not spending more on these various categories than you otherwise would, especially if you get a good restaurant cash-back deal.  Not to beat a deceased pony, but it makes zero sense to defeat the benefit of this strategy by over-spending.

4. Look up each account you obtain and note the monthly payment due date.  Prepare to pay off your monthly balances at least a week ahead of this deadline.  Don’t cut it close.

5. Stay on top of every account constantly.  One practice I do that helps me stay organized is to go into my online banking on my personal bank account and update the amount to be sent to each credit card issuer as I make the purchases.  I don’t suggest you rely on remembering to make these payments, or try to get cute in timing them.  Enter them well ahead of time and update the growing amounts until those payments are automatically paid on the dates you pre-set (remember, a week ahead of the actual payment due dates).

6. Have fun with your cash-back by putting $25 increments into gift cards for whatever.  Or better yet, if the card allows (most do), use the cash-back as a credit right back into your account.  This isn’t as fun, but makes better use of the funds you gained by using the cards.  It’s kinda cool to charge $238 worth of gas and pay only $213 because the other $25 came from rewards.  Over time, these savings really do add up to be significant.  To truly appreciate and enjoy the bounty, track these numbers and the overall return.

Credit cards are great if you use them smartly, and incredibly harmful if you don’t.  Be among the former.

**

DISCLAIMER:  This post represents the author’s opinion only, sometimes based on and supported by cited numbers and sometimes not. In no way should any part or all of the content of this post be interpreted as official financial advice, nor does it represent an intention to solicit readers into a specific strategy or investment.  Profitability is NEVER guaranteed.  Invest at your own risk.

Whoa… let’s back up for a moment

By BOB CUNNINGHAM

In case you didn’t already recognize the signs, this site is new… and is published by a blogging newbie.  I don’t mind admitting that.  I’ve been writing professionally nearly 30 years, for established publications and as a freelancer, but BuildWealthEarly.com represents my first foray into the blogosphere.

And as I was contemplating my next post, and briefly reviewing what I’ve released so far, it occurred to me that I have failed to share this blog’s true message – my actual philosophy on personal finance, and the often contrarian angle from which this subject matter will be provided in the coming weeks, months, and (hopefully) years.

Yes, I established in my introductory post that I am not a financial professional in the sense that I sport a bunch of impressive designations in front of my name – my only official title is as a licensed life insurance agent in California – but instead I am relying on a combination of my “PhD in the School of Hard Knocks” and some diligent research over the last decade-plus.

Still, I hadn’t truly shared my perspective – so here it is:

“Most of what you have learned about money, either from your parents, teachers/professors, or from so-called gurus, is NOT truly in your best interest.”

Say whaaat?

There are many, many valid basic points that I would never try to contradict – spend less, save more, know what you’re investing in, etc.  This is mostly common sense that doesn’t require you to read it in a blog post in order to recognize it as fiscal wisdom.

But the American system of, shall we call it, “public economics,” is mostly baloney. Our system is still the best in the world, in my opinion, but it falls shy of being truly valuable across the board for most citizens.  Far from it, actually.

I will give you one example now – trust me, you will get plenty more in future posts.  The 401K Plan.  We have been told that your company’s 401K plan is far and away the best way for an individual to save for retirement.  Put every dollar in that you can muster, many experts recommend.

As Col. Sherman Potter said on the 20th century TV show, “M*A*S*H*, at least once, “Monkey muffins!”

OK, so how would you react if I offered you the following savings plan? My strategy that I recommend to you is not liquid, meaning that once you put money into this instrument, you cannot retrieve it (for an emergency or any other reason) until the government says you can – beginning at age 59 1/2 and with the account open at least five years – unless you wish to pay a 10% penalty for the privilege.  This strategy frequently charges you among the highest fees in the industry, as much as 2.5% of your holdings annually, and gives you  little if any say in what specific investments your money will go into.  This strategy says to save a small amount on income taxes now, by having your contributions taken from your paycheck pre-tax, but pay a much larger gross amount of taxes in the future, when you are finally allowed to access the dough.  Oh, and if you happen not to need your money when you get past retirement age, well, that is irrelevant because when you turn 70 1/2 the government forces you to withdraw a minimum amount, the failure to do so costing you not only the taxes you would owe but IN ADDITION, a 50% penalty tax for good measure.

What do ya think?  Sound like a good way to go?

I just described the primary characteristics of the typical company-sponsored 401K plan.  Does Uncle Sam rock or what?

Now, to be fair, the 401K does have one desirable trait – the possibility of a company match.  Many companies offer some sort of matching funds to your contribution – a percentage of what you put in based on a percentage of your income.  But here’s the kicker – not every company offers a match.  In fact, according to multiple sources, the percentage of companies which offer matches, among those that sport 401K plans at all, is declining.

Under most typical circumstances, it makes sense for folks to contribute enough to their 401K plan in order to maximize the benefit of any company match.  But not always, and never a penny more than what counts toward the match.  There are simply other strategies available, which virtually anyone can utilize, that are significantly more beneficial than what Washington D.C. has laid out for you.

And very soon, we will be going into those.  Thanks for reading.

**

DISCLAIMER:  This post represents the author’s opinion only, sometimes based on and supported by cited numbers and sometimes not. In no way should any part or all of the content of this post be interpreted as official financial advice, nor does it represent an intention to solicit readers into a specific strategy or investment.  Profitability is NEVER guaranteed.  Invest at your own risk.

The real skinny on debt elimination

By BOB CUNNINGHAM

When it comes to strategies for accelerating the paying off of unsecured debt, I’ve seen a bunch of them.  Everything from straight-forward approaches based on math to “snowball” strategies that focus on the emotional gains that can be made by lower balances, depending on where you look.

So I figured it was time to clarify and summarize.

When we’re talking about debt elimination, we are referring primarily to unsecured debt.  Sure, a strategy for paying off all your bills, including your mortgage, has merit in the big scheme of things… but there is such a thing as “good debt.”  And in most cases, your mortgage qualifies as good debt.

When you have a large balance on a credit card, you’re at a distinct disadvantage because the rates, which can be as high at 27%, put you in the unenviable position of paying more in interest than you are towards the debt itself.  For instance, if you owe $2,000 on a credit card at 20% interest, the total interest for a year (assuming no added charges) would be $400.  That figure, divided by 12, would come out to about $33 per month in interest.

So assuming your credit card company requires a $50 minimum monthly payment, at the start of the aforementioned 12 months your payment would have $33 going to interest – pure profit for the credit card company – and only $17 toward reducing your debt.  So entering Month No. 2, your balance owed would not be $1,950 (after you paid $50 toward the $2,000 original balance) but instead would be $1,983.  If you were to attempt to pay off this account solely by making the minimum payment every month, you would need about 5 1/2 years and would fork over more than $3,300 for the right to borrow $2K – a 65% over-payment strictly because of interest.

Paying that way makes no sense, unless you prefer to grossly overpay for things, in which case I just put my 16-year-old Honda with 150K miles up for sale.  Fifteen grand, and it’s all yours.

No wonder Capital One can afford to pay Samuel L. Jackson and Jennifer Garner to hawk their cards.

Seriously, the need to pay off this debt is… well… serious.  So how best to do it?

If you have just one debt, say, the card balance just described above, you simply add every available extra dollar you can muster to that $50 payment – because every dollar you add will go directly toward the balance –  and pay the thing off much more quickly. Simple enough.

But what if you’re like most debt-challenged folks – with six different debts, ranging from a few hundred dollars to several thousand, each with unique APRs and minimum payments due.  What then?

Unlike many so-called finance experts, I will level with you and explain here that there is more than one responsible answer to this question.  But none are overly complicated.  And NONE require the help of a credit counseling service. You can do this completely on your own… trust me.  I’ve done it, long before I became the all-knowing wizard I am today (kidding, of course).

Here is the process, broken down into manageable steps:

1. List all your debts with the following information:  Creditor/phone number/account number, balance owed, minimum payment due, the day each month that the minimum payment is due, interest rate.

2. For any creditors who are charging you more than 12% interest, call their customer service departments and request a drop in your rate.  Explain that you have multiple debts, are making a concerted effort to reduce/eliminate your debt, and that their understanding and assistance would be appreciated. Point out (if it’s true) that you’ve made your payments on time and kept your account in good standing.  If the first rep you speak with indicates that he/she cannot help you, ask to speak to a supervisor.  If after speaking to management, you cannot get them to agree to a reduced rate, inform them that you will be transferring the balance to another card immediately and will never again use their card or services.  Be polite, but firm in letting them know that there is plenty of competition out there who will appreciate your business at a more competitive rate.  That often is the kicker to getting the company to agree to help.  And remember, even a 2% reduction in rate is better than nothing.  Don’t be greedy – just ask that they reduce it as much as possible. (some companies have been known to eliminate interest altogether for debtors in real trouble, but that is the exception rather than a rule).

3. Figure a year’s worth of interest on each debt by multiplying the balance owed and the interest rate.  Then take that figure and divide it into the minimum monthly payment amount.  Jot down the percentage you get. Why are we doing this?  Because we want to know which minimum payments give you the biggest bang for your buck each month, regardless of balance.

4. Now do some rankings – three lists, to be exact.  On List #1, rank your debts from lowest balances to highest.  On List #2, rank your debts from highest APR to lowest, and on List #3, rank the percentages you figured in No. 3 above in order from highest percentage going toward interest to lowest.

5. Now scan the three lists you just created.  Is there a creditor that appears to rank near the top on all three lists?  If so, that will be your first priority debt.  If it appears that two or more creditors are scattered among the top with no clear “winner,” you can either create a quick points system to rank them separately (only if you’re a numbers nut like me), or you can just continue reading here…

6. You now have a decision to make – how are you going to prioritize your debts, for the order you will focus on each one at the expense of the others. As I said early on, there is not just one answer here – because I like to incorporate the human element into this.  We are, after all, humans and not machines and we want realistic solutions.  If you are the type who needs positive reinforcement as often as possible, and truly enjoys the sense of accomplishment, go after the debt with the lowest balance first and use List #1 as your priority list. If you are mega-frugal and want to save as many pennies as well as dollars as possible, pick the debt with the highest APR first and use List #2.  I don’t recommend using List #3 exclusively – putting that together was just an extra tool for us.

7. Once you’ve decided on which list you will utilize, the remaining steps are these:  1) Add all extra funds to be dedicated toward debt elimination to the minimum payment on the first (priority) debt on your chosen list, and pay it ASAP.  Make the minimum required payment on all other debts ASAP (no later, obviously, than by the due date); 2) Do this each month until the priority debt is paid in full, then take the total payment amount you’ve been applying to the first debt and add it to the minimum payment on the second debt, and send that amount in to the second debt – the new priority debt – until it is paid off; 3) Continue taking the “snowballing” payment amount and adding to the minimum payment of the next debt on the list, until all your unsecured debt is history.

As you progress, the process rapidly accelerates as you dedicate the same amount of money monthly towards your total debt throughout.  DO NOT be tempted to decrease the payment amount at any time.

Nice!  Very cool accomplishment, that few folks achieve once they get in too deep.   You should treat yourself to an unscheduled nap in your favorite hammock.  WARNING!  Do NOT celebrate any part of this process by taking 14 friends out to a fancy dinner and putting the bill on one of your cards.  Think I’m joking?  You’d be surprised.

8. OK, last item is to put your cards where you will not be tempted to use them again. Do not destroy the cards, and do not cancel or close your accounts. Doing the latter hurts your credit rating, and eventually I want to show you how the savvy use of credit cards can add money to your assets column.  If you lack the discipline to avoid using them right after having paid them off, put them in a can with water and freeze the can.  That makes it a big hassle to access them, and improves your chances of thinking twice before making a purchase you will later regret.

Eventually, you will be thawing them out, but not for a little while yet.

**

DISCLAIMER:  This post represents the author’s opinion only, sometimes based on and supported by cited numbers and sometimes not. In no way should any part or all of the content of this post be interpreted as official financial advice, nor does it represent an intention to solicit readers into a specific strategy or investment.  Profitability is NEVER guaranteed.  Invest at your own risk.

Pay off debt or save? A quandary that is deceptively complicated

By BOB CUNNINGHAM

Another personal finance blog’s post on this subject caught my attention recently, and it got me to thinking that the question of whether to pay off debt as soon as possible, or maximize saving and investing, must be among the most-asked by Americans interested in smart money management.

The easy answer is to do both – after all, especially in the world of finance, how can diversification be a bad thing, right?  And the truth is, for most folks, paying off some debt and saving some money, too, probably IS prudent.

But there are factors that many gurus don’t properly consider, especially those who happen to come down particularly hard on either side of the aisle.

In the get-rid-of-that-nasty-debt-at-all-costs camp, the reasoning for paying off a 23% APR credit card ASAP is difficult to assail.  It’s sort of like an instant 23% return on your money… yeah, sort of.  Certainly, being able to ratchet that balance down rapidly is beneficial – a $120 minimum payment on $5,000 of credit card debt at 23% nets only about $24 going to principal, the other $96 pure interest profit for the company which issued the plastic.  That’s why you can end up paying nearly $20,000 to erase that debt if “you go the distance,” and just pay the minimum required each month.

But whenever you add money to the minimum, you have to figure the lost opportunity cost of not having that cash invested in a compounding account instead.  In other words, the interest goes both ways.  True, that performing asset is likely to fall way short of a 23% Rate Of Return, but in getting the money into the account earlier, you reap the rewards of more interest accrued long-term because of the magic of compounding.

The invest-as-much-as-you-can-and-don’t-worry-so-much-about-the-debt crowd, meanwhile, conveniently tends to overlook the lack of liquidity in most of the alleged best investments.  Want to build up your 401K and then use some of those funds to pay off that credit card?  Forget it.  Unless you’re turning 59 1/2 and are prepared to quit your job, it’s unlikely that will be an option for you.  And borrowing against your 401K generally defeats the purpose.

Also, don’t forget you will be paying taxes on your accrued savings when you finally do access it.  With the beefed up credit card payments, it’s after-tax dollars already so you get the full bang of your bucks toward eliminating principal.

I know… I haven’t really answered the question of which is wiser.  Well, here are some basic numbers using the following scenario:  An individual we will call Titus (why not?) is faced with a choice.  He makes $3,000 per month gross salary, has no savings yet, and owes $5,000 on a credit card at 20% interest with a minimum required monthly payment of $100.  His 401K at work offers a 50% match on up to 5% of his gross income, and is returning an average of 7.5% annually (figure 10% minus the typically exorbitant 2.5% of fees).  Lastly, Titus has determined he has $300 per month extra to dedicate either to savings or debt elimination.

If Titus opts to go after his credit card debt, at $400 per month ($300 extra plus the $100 minimum required payment), he will have his $5K debt paid off in about 15 months, after which he plans to put $300 monthly toward his 401K and improve his current standard of living with the $100 extra per month for discretionary spending.  After five years from the start of accelerating the pay-down of his debt, Titus has about $21,000 in his 401K with no debt. He achieved this with his $300 plus $75 from the company ($3,000 salary times 5% = $150 times 50% is $75), for 45 months. He went from minus $5,000 to plus $21,000.  Pretty sweet.

If there had been no company match, incidentally, he would have a little less than $17K.

On the other hand, if Titus chose to pay the $100 minimum on his debt and instead put the $300 toward his $401K, along with the $75 match, it would amount to about $27,000 in five years minus the $3,800 he would still owe on the card for a net gain of roughly $23,000.  Sans a company match, the net gain would be about $18K.

But before you key on $23K being more than $21K, one other factor needs to be considered:  Remember that Titus would not have the option of using the 401K money to pay off the $3,800 credit card balance, so that debt would continue charging 20% interest annually.  Chances are that this ongoing liability eats into (or completely decimates) what is otherwise a relatively small advantage for going the 401K route.

In the end, it is the company match of the 401K and the interest we credited in this example that pushed the pendulum towards not accelerating the pay-off of the credit card initially.  But what if we endured a down market during this five years and the return was only 3%?  Wouldn’t that make paying off the debt come out significantly better?  Yep.

Ah, and remember that Titus took $100 a month after the debt elimination and began using it as extra spending money.  He improved his budget flexibility, and that’s a tangible gain too.  I incorporated this into the example because it’s my opinion a large percentage of folks, faced with having $400 to “play with” after eliminating a debt, would choose to have fun with a portion of it.

Ultimately, in my opinion, a credit card debt at 20% interest should be your first and only priority because it is definitive, non-taxed progress.  Opting to contribute to the 401K up until the company match is maxed and then turning your attention to the credit card debt certainly is logical – you’ll never get a truly dissenting vote from me even if the math leans otherwise.

But ignoring the available acceleration of paying off big debt in order to pad your retirement account contributions is essentially leaping over dollars for quarters.

**

DISCLAIMER:  This post represents the author’s opinion only, sometimes based on and supported by cited numbers and sometimes not. In no way should any part or all of the content of this post be interpreted as official financial advice, nor does it represent an intention to solicit readers into a specific strategy or investment.  Profitability is NEVER guaranteed.  Invest at your own risk.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Truly, you CAN retire earlier than by age 65

Thank you for stopping by my website, and welcome.

If you were to do research on me and my credentials in the world of personal finance, you wouldn’t find a lot of impressive-looking acronyms nor are there many lofty degrees or designations I can cite as qualifications.  I am a professional life insurance agent who, through the SOHK (School Of Hard Knocks) over the first 35 years or so of my adult life, has learned a great many simple strategies that are often unconventional yet clearly beneficial.

Heck, a few of the tactics and techniques I intend to share on this site weekly are downright opposed by the mainstream financial community.  And yet, I’m here to tell you straight-up that they are superior for a healthy, wealthy life to conventional methods such as focusing on your job’s 401K plan for savings, or avoiding credit cards under all circumstances, or buying term insurance and investing the difference.

The real truth?  You should mostly avoid government programs, can benefit from having multiple credit cards, and would be smart to make permanent life insurance a central focus of your planning.

But there’s plenty of time to dive into all of that.  And rest assured, this site isn’t about beating you over the head with insurance product pitches.  Truth is, many of you need more basic assistance before you’re ready to delve into more advanced strategies.  And I’m here to show you the way from the beginning.

While I believe the information you will find here can benefit folks of all ages, much of the content is designed to get younger adults/families off to a strong financial start.  The earlier you start saving, for example, the more benefit you will reap from the amazing wonder that is compound interest.  And seriously, starting to save in your early 20’s versus waiting until your 30’s or later can make a monumental difference on how much you can compile, which in turn, goes a long way toward determining how early you can stop working and live on what you have already – if you choose to go that route.

Bottom line:  Do these things correctly from the get-go and you could realistically retire by your late-40’s with a superior level of independence to those who are forced to wait to the traditional age 65, or even longer.

So I would be greatly honored if you’d be willing to check back to this site each week to read my latest post.  And by all means, I welcome feedback – both complimentary and critical are appreciated, as long as it’s constructive.

Thanks again for reading.

-Bob Cunningham